When Should You Refinance Your Home?

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The change of interest rates as well as fluctuations in the economy always begs the question of refinance and if it’s right for you. While people may try, no one can predict the future, and the political and economic landscape of the country as well as stability of your family finances, can weigh heavily on your decision. However, there are some practical considerations in determining whether you might benefit from refinancing your mortgage.

Compare Interest Rates and Determine Closing Costs

Look at the interest rate. Is it ticking upwards or headed down? While projections, are well, projections, it is good to get a sense of where interest rates are headed. If the interest rate is .75 – 1.0 lower than what you are paying on your current mortgage, you might want to check with a loan officer or mortgage broker and start the prequalification process.  Keep in mind that your credit score will be a key determining factor on the interest rate you will receive on a new loan, and a Good Faith Estimate (GFE) can let you know what your estimated interest, closing costs, and monthly payments will be. It can also help you compare loan terms and charges with those from other lenders and brokers. If you aren’t ready to contact a loan officer, you can get a rough estimate with a home refinance calculator.

When determining whether to refinance, look carefully at your total estimated closing costs. Unfortunately, because a refinance is the process of taking out a new loan to pay the balance of your old loan, there are always a great deal of fees that come with that process. You will need to weigh the balance of your closing costs with the total amount saved on a lower interest rate and determine how long you will have to stay in your current home to break even and make the costs of refinance worth it. For example, if refinancing will save you $130 on your house payment (principal and interest) each month, but your closing costs are $2800, it will take you nearly 22 months to break even. However, because $130 a month can add up to a lot of money over the life of the loan, refinancing might be a good idea if you intend to stay in your home for the foreseeable future, or at least more than a few years.

Consider the Value of Your Home

One of the pesky requirements of home loans is the PMI (Private Mortgage Insurances) paid by borrowers with less than 20% down payment at closing. Although this insurance will be cancelled once a borrower attains 78% loan to value ratio (LTV) on their home, refinancing can throw a wrench into the situation. A new loan used to refinance also carries the same conditions of PMI, and most lenders will order an appraisal to determine if you need to continue PMI. Carefully determine the market value of your home so that you don’t get stuck with a new loan that could extend expensive PMI costs longer than was initially necessary.

Evaluate the Terms of Your Loan

Looking at the type of loan you currently have and comparing it to one that might be more financially practical can help you determine if refinancing is a good option for you. If your loan is an ARM (adjustable-rate mortgage) you have most likely enjoyed a period of time of low payments. However, if you are concerned about the uncertainty of interest rates and possible upward projections, it might be time to refinance to either a new ARM or a fixed-rate mortgage. Again, weighing the fees, while comparing monthly payments (along with channeling your inner fortune teller) can help make that determination.

You also might want to consider refinancing to shorten the term of your loan. If your financial situation has improved since you signed on a 30-year loan and you now have the ability to make a larger house payment, you may want to refinance to a 15-year loan in order to pay off your home in a shorter amount of time. This is especially true if your current loan and subsequent house payment extends years into your retirement, when you may be forced to live on a tighter budget.  While your payments will most likely be steeper than before, it will cut down many years of those payments; and as a result, shave off thousands of dollars of interest payments in the process. Even if you elect a 30-year loan, it is possible that there is not a prepayment penalty. Making extra payments can save you money in the long run. See how much you could save with a mortgage loan early payoff calculator.

Word of Caution

Refinancing can be a great tool if it is used to save money by shortening the length of your loan or by securing a loan that can bring stability in a tumultuous economic climate. However, refinancing should be entered into with caution. Too often, borrowers see refinance as an opportunity to consolidate debt or to access the equity they have built into their home. While cash-out refis are often used for home improvements that are thought to bring value to the home, one must consider the total costs of taking out the hard-earned equity that may have been building in a home for years and using it for something that may or may not bring more equity or value to the home. Since the terms of refinance loans can be from 10, 15, to 30 years, using money from a refinance can add years of added interest to purchases that will decrease in value. Taking cash out, can also add more to your payments even if you secured a lower interest rate.

Another possible pitfall of refinance is one that adds more years to your loan. If you currently have a 15-year loan and refinance to one that is a 30-year, chances are you will lower your payment but will pay much more to finance your home than if you kept your original loan. Or, with a lower interest rate, you may be tempted to refinance your 30 year-fixed loan to another loan with the same repayment schedule of 30 years starting payments all over again. This just keeps you in debt that much longer and accruing interest along the way.

Remember to use wisdom when deciding to refinance. Your home is likely to be one of your greatest assets. Refinancing can be a great instrument to gain more equity in your home by paying your mortgage down faster. However, if not careful you can increase your financial burden by extending payments and debt into an unknown future.  When it comes to the decision of refinancing a home mortgage, asses your situation carefully and proceed with caution.